Researchers Say Insurance Rate Regulation Drives Up Its Cost

NU Online News Service, Sept. 11, 2:14 p.m. EDT

An analysis of property insurance trends by two academics suggests that post-disaster property insurance rate regulation actually drives up the prices it purports to control.

In their policy report from the Independent Institute titled "Catastrophes and Performance in Property Insurance," economists Patricia H. Born and Barbara Klimaszewski-Blettner performed a detailed analysis of trends in the industry over 23 years and, they argue, that post-disaster property insurance regulation actually drives up the prices it purports to control.

Ms. Born is an associate professor at the College of Business at Florida State University and a research associate in the Florida Catastrophic Storm Risk Management Center, and Ms. Klimaszewski-Blettner, a research assistant and doctoral candidate at the Munich School of Management's Institute for Risk and Insurance Management at Ludwig-Maximilians-Universitaet Munich, Germany.

Their 33-page report draws on data from the National Association of Insurance Commissioners and the Swiss Re Sigma reports.

They argue that strict regulatory environments induce higher losses from unexpected catastrophes, as firms are unable to adjust prices in light of changing conditions.

Commercial insurers, they assert, experience less loss following catastrophes than the homeowners insurance market due to greater flexibility and fewer constraints.

Their report says that in states such as Florida, regulations that include premium limitations or exit restrictions can cause severe market distortions that may result in "an inadequate supply of insurance coverage."

When restrictions on premium adjustments are enforced, insurers "may choose to exit the market if rates are not adequate to maintain solvency. This, in turn, prompts regulators to impose exit restrictions or cancellation bans," their report says.

Addressing wide variations in state-level regulation, the researchers dissect the phenomenon of "regulatory chain reactions," in which one intervention seems to establish the "necessity" for more government action. This snowball effect, they find, actually exposes taxpayers and consumers to greater risk when disaster hits.

Considering the staggering losses by insurers in 2005–$45 billion for Hurricane Katrina alone–the authors propose several reform measures to protect both insurers and policyholders.

They propose deregulating prices and a reform of residual market solutions "with emphasis on allowing market forces to operate more freely in responding to the insurance needs."

In considering low-income people in affected areas who are unable to move or afford coverage, they suggest that even direct state subsidization of premiums is preferable (but hardly ideal) to keeping premiums artificially low, while cautioning that "incentive-incompatible subsidization of premiums–for example, for new buildings in high risk areas" must be avoided.

The researchers say that, "the natural disasters of 2005 cannot be seen as unusual outliers, but reflect the continuing trend" of increasingly frequent and severe natural disasters.

The full report is available at www.independent.org, an independent, politically unaffiliated think tank based in Oakland, Calif.